1. Field of Invention
This invention relates to hedge funds, specifically to an improved method of ranking and rating hedge funds.
2. Prior Art
Rating methodologies in financial services are helpful for the end user, or investor, to quickly learn of high and low quality investment options, without the need for detailed analysis or extensive knowledge about the field.
A published patent and patent application search reveals no hedge fund rating system patents existing or in process today.
Most hedge fund ranking systems and most financial services ranking and rating tools use a basic straight-line sorting mechanism. That sorting mechanism allows a user to choose from a menu of hedge fund characteristics, such as assets under management, volatility, Sharpe Ratio, returns, time, and others, and to state various criteria limits to those hedge fund characteristics. For example, a user can state that he is interested in hedge funds over $300 million in assets, annualized volatility under 7%, annualized returns over 15%, etc. A certain subset of hedge funds, fitting stated criteria, from a database is returned from the sorting mechanism, based on the limitations stated.
There are a number of flaws to such a sorting mechanism. Firstly, it returns only a subset of funds from the database, those fitting all of the criteria stipulated in the sort, disallowing the user from viewing all of the funds in the database on a relative basis. Next, the sorting mechanism evaluates the first characteristic independently, stores the funds that fit that criteria, evaluates the next characteristic, stores the funds that fit that characteristic, etc. This reduces the quality of fund selection further, ruling out a fund that may be superior to all in the database according to one criteria, yet inferior according to other criteria. Finally, the sorting mechanism does not assign a value to each fund. Moreover, there is no system that this inventor knows of in place today that assigns values within a stated and finite range allowing all funds in a database to compared on a detailed, relative and continuous basis.
Arguably, the best known mutual fund rating system is that of Morningstar. Morningstar's simple rating methodology analyzes risk-adjusted returns over 10-year, 5-year, and 3-year time frames, weighting them 50%, 30%, and 20% respectively1. These resultant scores are compared across specific style, with the top 10% of scores assigned 5 stars, the next 22½% assigned 4 stars, the middle 35% assigned 3 stars, the next 22½% assigned 2 stars, and the bottom 10% assigned 1 star. There are a number of shortcomings to this method overall, and specifically with application to hedge funds. How Does Morningstar Rate Funds? Morningstar, Inc.
Firstly, this method does not allow for a comparison of one fund versus all funds in an entire database; it is only applied to funds within the same style group. Next, Morningstar's methodology is relative, not absolute. There is no absolute numerical rating falling within a specified range of numbers, at which to compare the funds on an ongoing basis. Furthermore, this method does not have a robustness or flexibility to satisfy the diverse nature and various aspects of hedge funds.
Standard and Poor's currently rates hedge funds that are located outside the United States through company affiliates that were recently acquired. They take a qualitative approach to evaluating a hedge funds' overall business, much like the company's approach to rating a bond. While qualitative analysis has its advantages, it is impossible to systematically evaluate hedge funds ongoing with such a methodology.
Fitch Ratings takes a qualitative approach to rating hedge funds. The company's methodology is one of assessing the management team, time in business, cash on the books, and other overall business health concerns, in addition to general performance information. Currently Fitch has rated only a few fund companies due to the time-consuming efforts associated with their rating methodology. It is impossible to evaluate thousands of funds simultaneously with such a methodology.
According to the website of The Hedge Fund Consistency Index, “The Hedge Fund Consistency Index: profiles 4000 hedge funds. It also ranks 4000 hedge funds according to the Consistency Index. It is available only for qualified, eligible sophisticated investors. Qualified investors can register for access to the profiles, rankings and the formula for the consistency index.” There is little additional information available on this ranking methodology. According to the company's data provider, Barclay Trading Group Ltd, contact information is not permitted to be sold with the ratings to subscribers. A rating system not accompanied by contact information lacks value to the user, as the user does not know where to go to locate a highly rated fund.
Allenbridge Hedge Info is a UK-based firm that rates hedge funds and other investment products. The company recently announced that they are adopting a hedge funds awards model in cooperation with MARHedge, a hedge fund news service wholly-owned by a UK parent company, Metal Bulletin plc. While little information is known on the rating methodology of Allenbridge Hedge Info, a recent news release with a quote from a director of the company sheds light on their model. Speaking about their jointly-held awards dinner, “There were definitely some surprises among the winners but we felt very strongly that the judging process needed to reflect not just performance but also volatility, risk and compliance issues,” added Jacob H. Schmidt, director of hedge fund research at Allenbridge Hedgeinfo. “We passed over some funds with triple-digit performance records. It was important to us to evaluate funds holistically, as investors do, and we remained true to that objective.” This reveals that part of the rating process is subjective and left up to a panel of judges. In other words, there is a humanistic element to that type of rating process, and therefore it is not entirely systematic or quantitative. Such a method does not entirely leave the process of ranking a fund to a quantitative process, and by its nature, does not lend itself to a comparative, ongoing ranking and rating tool.
Global Fund Analysis (GFA) uses “in-depth question and answer interviews” to allow their team of analysts to assign ratings to funds, currently 50 are rated by the company. GFA puts funds through a “screening process”. They look at investment style, adviser group, risk management, performance history. GFA's analysis, while partially quantitative, is largely qualitative in nature, the qualitative analysis performed by a team of analysts, and their method does not encompass an absolute rating at which hedge funds can be compared on an ongoing basis.
In U.S. Patent Application #20050075962, Dunne, Richard C., “Method for analyzing investments using overlapping periods,” this method specifically relates to “performance and diversification” and is limiting in its scope with a different derivation technique than the invention contained in this application. Further benefits to this referenced invention, specific to robustness, are explained later in describing my invention's objects and advantages.